KraneShares Dynamic Emerging Markets Strategy ETF
Q2 2017 Earnings Call Transcript

Published: 1 Nov 2016

[Executives:]

Richard Vatinelle - Vice President and Treasurer Per Loof - Chief Executive Officer Bill Lowe - Executive Vice President and Chief Financial Officer

[Analysts:]

Matt Sheerin - Stifel Josh Nichols - B. Riley Aaron Martin - AIGH Investment Marco Rodriguez - Stonegate Capital

[Operator:]

Good morning. My name is Andrea and I'll be your conference operator today. At this time, I'd like to welcome everyone to the KEMET Reports Second Quarter 2017 Results Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I would like to now turn the call over to your host, Mr. Richard Vatinelle. You may being.

[Richard Vatinelle:]

Thank you, Andrew, and good morning everyone. This is Richard Vatinelle. Welcome to KEMET's conference call to discuss the financial results for the second quarter of fiscal year 2017 ending September 30. Joining me today on the call is Per Loof, Chief Executive Officer, and Bill Lowe, Executive Vice President and Chief Financial Officer. As a reminder to you, a presentation is available on the website that should help you follow along in the financial portion of the presentation. Before we begin, we'd like to advise you that all statements addressing expectations or projections about the future are forward-looking statements. Some of these statements include words such as expects, anticipates, plans, intends, projects and indicates. Although they reflect our current expectations, these statements are not guarantees of future performance and they involve a number of risks, uncertainties and assumptions. Please refer to our 10-Ks or 10-Qs and our registration filing statement for additional information on the risk and uncertainties. Now, I will turn the call over to Per.

[Per Loof:]

Thank you, Richard, and good morning, everyone. We had a strong second quarter with revenue of $187.3 million, which was within the forecasted – actually upper end of the forecasted range. Adjusted EBITDA was up approximately $2.6 million from last quarter at $26.9 million and our cash balance again exceed our forecast $37.4 million ahead of September 30, 2015 a year ago. Compared to the prior quarter, GAAP gross margin improved another 180 basis points to 24.8% from 23%. Non-GAAP gross margin was at 25%, our timeline model target. Our objective is to ensure that we are profitable and predictable and I think this quarter shows just that. We expect this trend to continue. Comparing the quarter with the year ago September 30, 2015, revenue was up just slightly year-over-year, less than 1%, but adjusted EBITDA is up 10.2%. Markets continue, we believe, to remain stable. Asia, however, is showing some signs of improvement and I will talk more about that later when I discuss the regions in our business segments. Well, for now, let me first address some comments to the NEC TOKIN transaction. We continue to wait for additional news from the remaining jurisdictions. We didn’t expect to receive any news during the summer months and now that we are into fall, our expectations are cautiously optimistic that one or more of the remaining jurisdictions will notify [indiscernible] before the end of the calendar year. We are still optimistic that we will be able to complete the acquisition by the end of our fiscal year ending in March 2017. Our synergy teams continue to work towards integration and the energy level remains very high within both companies as we’ve planned for the event. With that, I will turn over to Bill for comments on our financial results for the quarter. Bill?

[Bill Lowe:]

Thank you, Per, and good morning, everyone. I will begin my review on Slide 3 if you are following along on the website. As Per said, net sales for the quarter were $187.3 million, which is up 1.3% compared to the prior quarter of $184.9 million. GAAP gross margin percentage was higher by approximately 180 basis points from 23% to 24.8% and our GAAP net loss was $5 million or $0.11 per basic and diluted share compared to a net loss of $12.2 million or $0.26 per basic and diluted share compared to the prior quarter of June 2016. Included in the net income this quarter is a $6.2 million asset impairment charge related to seizing operations at our Tennessee foil plant and relocation of our K-Salt manufacturing plant within Mexico. Additional restructuring charges related to these actions and other restructuring totaled another $4 million for a total $10.2 million impact during this quarter on GAAP financial statements. As we stated in our previous press releases related to these events, we expect to achieve further margin, cash flow and earnings improvement as a result. These benefits begin primarily January 1. Moving to Slide 4, our non-GAAP gross margin percentage, as Per said earlier, increased by 160 basis points to 25% compared to 23.4% in the prior quarter and our non-GAAP adjusted net income was $0.15 per basic share and $0.13 per diluted share. Our adjusted EBITDA for the quarter was $26.9 million, up 10.9% from $24.3 million in the prior quarter. Non-GAAP SG&A expenses of $22.5 million were slightly up compared to $22 million in the prior quarter of June and our expectation for the next quarter is a range of $22 million to $22.7 million. Let’s move forward to Slide 5. Capital expenditures during the quarter were $4.2 million compared to $6.2 million in the prior quarter. For the coming quarter, we expect to spend in the range of $6 million to $8 million in capital expenditures for the full year 2017 will again be in the range of $22 million to $25 million. Regarding our forecasted cash balance, which can be found on Slide 6, we finished the quarter with $74.8 million, which is approximately $4.8 million more than our forecast. Our expectations for the ending cash balance at December 31 is a slight decrease from this quarter to approximately $70 million as our semi-annual coupon payment is due this quarter and actually was paid today. Adjusted EBITDA for the quarter was $26.9 million and adjusted EBITDA margin trend has increased to 14.4% from 9.4% seven quarters ago. Additionally, LTM adjusted EBITDA margin have increased steadily from 11.6% to 13.3% since December 2015 as noted on Slide 8. Regarding the performance of NEC TOKIN, revenue in the second quarter was 130.5 oku yen or approximately $126.6 million. Our share with our financial results for the quarter was an equity income of $200,000 and their cash balance remains healthy at approximately $114.1 million and their EBITDA for the quarter in U.S. dollars excluding legal fees was $16.3 million. Now, I'll turn the call back over to Per for his comments on the markets and our business units.

[Per Loof:]

Thank you, Bill. Let’s take a look at our performance by market segments, which can be found on Slide 13. On a percent of revenue basis, the automotive segment shows a slight increase now at 21% of our total business. The industrial, telecommunications, and computer segments remain stable at 24%, 20% and 15% respectively. Also stable were the medical and defense segments at 7% and 5% respectively. The consumer segment at 8% was slightly down compared to last quarter. Turning to our business group, in the solid capacitor group revenues versus prior quarter was up $700,000 or 0.5% at $142.6 million. Seasonal strength in the OEM channel drove the quarter-over-quarter improvement. Distribution channel revenue was stable relatively to Q1 performance. Gross margin for Q2 was approximately 31%, up approximately 200 basis points versus prior quarter and driven by continued success in our cost and mix enhancement initiatives. As we ended Q3, order rates and backlog are stable; however, we do expect to see seasonal weakness late in the quarter as we enter the holiday season. Our film and electrolytic business revenue was $44.7 million as compared to $43 million last quarter, an increase of $1.7 million. Revenue from Europe and America accounted for most of the revenue increase. Orders continue to improve as evidenced by our book-to-bill of 1.08 for the quarter. Gross margin for this business increased to 5.6% versus 3.7% for the previous quarter. This increase was driven by higher revenue and improving manufacturing costs. The group is focused on continuing to increase revenue by working with OEM and distributors on projects and segments which are growing. Additionally the group is focused on continuing to reduce cost by closing our Tennessee factor and consolidating aluminum analytic R&D center in Weymouth, England into our manufacturing operations in Évora Portugal. Now to the regions. Europe closed with $60 million in revenue basically flat versus last quarter. We continue to see improvement in the region especially in the automotive segment with strong R&D activity in the electric and hybrid vehicle side. POS closed at $35.2 million, down 5% from previous quarter due to the summer holiday [indiscernible] 4% if we compare to the same quarter a year ago. Inventory in the channel remain stable with the book-to-bill at the quarter at 1.05. It was a good quarter for Asia as we continue to see improvements in this region. Revenue was up 1.6% to $70.5 million. POS also improved by 10% to $39.8 million. Q2 revenue in the Americas finished up 3% over the last quarter, ended at $56.8 million. POS was down from last quarter 8% to $35 million. It turn out to be the challenging POS market last quarter. The America's focus continues to be driving the POS numbers to define specialty products and to continue to feed the market growth. Distribution inventory within the Americas is at a healthy level to support these efforts. The Americas book to bill continues to be positive. Distribution revenue was flat versus the previous quarter, but improved approximately 13% versus the same period a year ago with POS down 2% compared to last quarter but up 4% versus the year before. Inventory in the distribution channel remains relatively stable. We did maintain our focused efforts with our channel partners to drive growth and POS demand while maintaining balance and the inventory levels and revenue patterns. Looking forward to next quarter, we see the normal seasonal third quarter impact on our top line. Bill indicated in his presentation early in September at the Deutsche Bank Leveraged Finance Conference that the third fiscal year traditionally is a little softer. We continue to believe that we are forecasting our sales to be in the range of $181 million to $186 million, slightly down from the September quarter. However, gross margin should be in a narrowband between 24.1% and 24.6% with SG&A flat compared to September results in expectation of another good solid quarter which illustrate the seasonal revenue fluctuation. In summary, we continue to perform at the operating level. We continue to generate cash at or above our forecast and our operating income trend continues to be positive, now six quarters in a row. And our margins continue to remain solid and have approached our timeless model target. We have created significant operating leverage within our cost structure. Our third quarter has started as expected in all regions and while the month of December is always a wild card we anticipate a solid third quarter December 31. As always, thanks to our hard working people that continue to make the extra effort to improve our performance and enhance our customers’ experience. And this concludes our prepared comments and we'll be happy to respond to any of your questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Matt Sheerin with Stifel.

[Per Loof:]

Hi, Matt.

[Matt Sheerin:]

Yes. Hi, good morning guys. Just a couple of questions. On the gross margin up truly significantly and basically your target, you talked about mix and leverage continued cost cutting. Could you elaborate a little bit more on that how you got there?

[Bill Lowe:]

All units are performing better and we are seeing - continue to see improvements in our mix. We continue to see newly created products take a bigger share of our revenue and therefore improving our margins. We also continue to find opportunities to rationalize the manufacturing footprint and that continues. We’ve taken two steps this quarter to close two roofs and of course that has a great impact on our performance. We noted in a press release just recently that these two specific efforts, one in Mexico and one in Tennessee will help the bottom line from $6 million to $7 million annually starting little bit this quarter but mostly in January 01. So we continue to see improvements in all aspects of our cost structure. And we have – there is more we can do. So we believe that the trend that we have at this point will continue going into the following quarters. We feel pretty good about where we are at right now.

[Matt Sheerin:]

Yes, for sure. And on pricing, it looks like your sales were stable top a little bit. Are you seeing more favorable pricing or just not as much pressure on the pricing area and did that help a little bit too?

[Per Loof:]

This is, as you know, Matt, this is a business where pricing is always a topic. And we continue to make sure that we can stay competitive and we need to – in the way we say competitor that is to ensure that our cost structure is competitive and that’s what is we are going to continue. I don’t think we have crazy pricing trends at the moment but really our customers want to have the best value they can get and that continues to be an ongoing conversation. But from a pricing perspective, it’s where we expected it to be actually.

[Matt Sheerin:]

And you’re guiding gross margin down a little bit and I assume that’s due to slightly lower volume and year end your factor shut downs and that sort of thing?

[Per Loof:]

Yes, that’s all volume related, all related to Christmas basically. As we know, December is always a bit of a wild card. Having said that, we started this quarter stronger than last quarter where we had across the board so far into the quarter. The first month closed better both in orders and then sales than last quarter. Having said that, we’ve got Christmas to [indiscernible] and there’s always a little bit to see how that falls.

[Matt Sheerin:]

Okay. And on NEC TOKIN just a few question, first, on the settlements with various jurisdictions, could you remind us how many has left and how much you have reserved for the finds there? And then in terms of getting the deal done by basically the end of your fiscal year which is in the March quarter, you’ve got to settle these settlements to work out and then of course you’ve got to restructure your debt. So can you talk us through the timelines and what needs to happen between now and the end of March for that deal to actually close?

[Per Loof:]

I can tell you a few things, Matt, but of course I can’t go into a lot of details on how we’re going to do it. On the jurisdiction, there are two jurisdictions that are important that we’re waiting for, that is Korea – South Korea and within European Union. The others are either small or down. And we have reserved I think Bill we reserved $86 million for all the finds and we still think that didn’t change this quarter so that what lead to our legal teams and plenty of them not going to show you that thing to believe. So I think that’s – I’ll let Bill comment on that as well. In terms of getting the thing done, clearly there is an objective from all companies to have this thing done by the end of this fiscal for all kind. So that’s really what we’re programmed for.

[Bill Lowe:]

We said that in the past, nothing that has happened and the recent past has changed that.

[Matt Sheerin:]

Okay. And just lastly on that, I know it sounds like you’re working on – it seems working on synergies. Could you remind us what you’re thinking and maybe it’s too early to tell about what the combined entity would look like from an EBITDA standpoint and a margin standpoint?

[Bill Lowe:]

What I can’t say is what we have said before. We believe there is a close to $40 million synergy opportunity for that to – is coming together.

[Matt Sheerin:]

Okay, great. All right. Thanks for your help.

[Bill Lowe:]

Okay. Thanks, Matt.

[Operator:]

And your next question comes from the line of Josh Nichols with B. Riley.

[Josh Nichols:]

I know that you mentioned that you’re looking to achieve a target of 25% gross margins. Looking at how strong gross margins were this quarter, do you think it’s feasible that it could be at that level I’d say Q4 this year and is there any upside to that looking into next year potentially?

[Per Loof:]

I’ll let Bill comment on that too but we are – on a GAAP basis, we are at 25% now and there is still more work to do. That would give us an opportunity to improve that further but we have an operating target of 10 and we’re not quite there yet. So we’ve got a little bit more to do and will that falls in the SG&A side or above the line is another topic.

[Bill Lowe:]

Per already mentioned actually is that we’ve got some of these projects which we actually announced for the financial impact. This quarter we will start to have benefit in the financial statements at the operating line and gross margin line more so in the fourth fiscal quarter. So I mean I think Per is right, there is an opportunity to get there on both the GAAP and the non-GAAP side of it at the 25% level. I think it’s certainly an opportunity for that barring things that we can’t see that far in advance. But from actions we’ve already taken, the action that will start of flow through the financial, income statement that fourth fiscal quarter not in the statement this coming quarter.

[Per Loof:]

And let me tell you that I think the other thing about the – we are achieving this with these revenue levels and I think that’s what’s significant here that which means there is significant leverage in the model here.

[Josh Nichols:]

Great. And then cash generation has actually been above expectations as you noted but it looks like the company is still guiding to $90 million of cash by year-end, why is that?

[Bill Lowe:]

That’s great. We are holding to that number for now as we wait to see what – we may – we may decide to do along our – kind of our CapEx forecast. There is kind of $20 million to $25 million in that forecast as well as when – again, back to these restructuring items we just announced, one them actually has a working capital benefit and it’s a question of when that starts to actually kick-in. So you are right to notice that that there is certain a possibility that that $90 million is not $90 million, that it’s is $90 million plus and of course we are working to make it $90 million plus, but we are holding it at $90 million at the moment. I think when we get – when we get it in the next earnings call, so you will certainly revised where we think it’s going to fall. We are working to make it greater than $90 million. Those are the factors why we would cap it at $90 million at the moment.

[Josh Nichols:]

Great. And then nice improvement eventually in the F&D segment on the revenue side as well as the margin front. How should we think about that business over the next couple of quarters now that the restructuring is largely done and there is additional product line that helping to bolster it?

[Per Loof:]

We are projecting continuous steady improvement in that sector and we should be able to see that.

[Josh Nichols:]

Thank you.

[Per Loof:]

Okay.

[Operator:]

And you next question comes from the line of Aaron Martin with AIGH Investment.

[Aaron Martin:]

Hi, good morning. Congratulations on the strong progress guys. Bill, update in terms of the [indiscernible] manufacturing in terms of the cost – the cash cost, I think it’s a very wide range you initially reported it, and where is that coming out?

[Bill Lowe:]

I missed the very beginning of the question as it was a little garble for us here. So I apologize, I didn’t catch exactly.

[Aaron Martin:]

In terms on the restructuring actions and the closing of the manufacturing, it was a range of like $500,000 to $3 million I believe in terms of cash costs?

[Bill Lowe:]

Yes. That range has to do with the termination of the contract that we are working through and we don’t know exactly where we are going to fall with that. So we got some severance, there is some severances to cash and then we are working through termination of a contract that we have – we’ve established a range for it, but not – we don’t have a set number. So that’s why there is a wide range in that particular category.

[Aaron Martin:]

Are you assuming you are going to have that all taken care of by the end of the fiscal year and how that relates to the cash balance?

[Bill Lowe:]

Yeah, yes, yes.

[Aaron Martin:]

Okay. So it’s part of the varying item there. Okay. Thank you.

[Operator:]

[Operator Instructions] You do have a question from the line of Marco Rodriguez from Stonegate Capital.

[Per Loof:]

Great. Hi, Marco.

[Bill Lowe:]

Hello, Marco.

[Marco Rodriguez:]

Hi, guys. Thanks for taking my question here. Most of my questions have actually been asked, but I do have a couple of follow-ups on prior questions. Just first off, coming back to the new restructuring or the new margin improvement actions you are taking here specifically on the solid capacitor side with the K-Salt facility. Was that – can you talk a little bit more about that in terms of – what was kind of the driving force, was it just your normal Six Sigma type stuff you guys were doing or is this something else you saw down the road?

[Per Loof:]

It is clearly a Six Sigma stuff, it is an opportunity for us to use the facility that we already have. We have consolidated a number of activities within Mexico, within our tantalum business and there were space in the Matamoros facility to do more and therefore there is an opportunity to move the K-Salt facility that we have on one side account into the one – large facility we have in Matamoros. It is also part of – with one of our partners to make sure that we can be more efficient in how we handle the whole ore traffic and that’s what is going to drive the improvement in working capital. So it’s a bit of a combination of improving working capital as well as improving the cost of manufacturing by being able to basically take one facility out and also as a result of that we were able to – fewer people of course. So that’s what this is about.

[Marco Rodriguez:]

Got it.

[Per Loof:]

And the reason we didn’t go into the one facility in the first place was we needed that quicker and we needed a facility that has some specific capabilities that our current facility didn’t have, but now have. So that’s really what’s driving this action. And of course, we always look for opportunities to improve our margins of course.

[Marco Rodriguez:]

Got you. Got you, okay. And then if I hear you currently, I want to make sure I interpreted the answer to prior question in terms of the gross margin expectations. Obviously, you were pretty much on a non-GAAP basis hitting your timely model 25%. I know the expectation was for it to kind of be hit a little bit in a few more quarters. But now with this new action, I just want to confirm I understood that now that 25% is likely going to be a higher number basically. Is that fair? Is that how we should be thinking about them?

[Per Loof:]

I mean if the current trends continue and if the market continue to be stable and not deteriorate then I think your assessment is correct then our margins will continue to improve.

[Marco Rodriguez:]

Got you. And then switching gears here on the F&E side, apparently in your prepared remarks you talked about working with some of your OEMs to drive better revenue opportunities for the F&D side, can you talk a little bit more about that? What sort of initiatives you are going through there with them?

[Per Loof:]

A lot of them are automotive related and some of them are very large with big OEMs. And the issue with automotive segment is once you make the sale as you like and get not the [indiscernible], it’s going to take a while for that production to start, so it will kick-in over time. So just to give you number, right now, we are looking at over 30% of the sales we are making now in the segment are with new products and of course at low volumes potentially. So potentially we have an opportunity to see that revenue kick-in over the next several quarter. So I think the fact that we are in automotive, we are very focused on the hybrid side of the section as well as an industrial growth opportunity there, I think, will give us chance to A) improve our revenue and also improve the margin situation.

[Marco Rodriguez:]

Got you. Great. I appreciate your time guys, thanks.

[Per Loof:]

Thank you, Marco.

[Bill Lowe:]

Thanks.

[Operator:]

And at this time, there are no further questions.

[Per Loof:]

No other questions? Well, if no other questions, thank you very much for joining us in this call this morning and thank you for your interest in our company and we should all [indiscernible].

[Operator:]

Thank you, ladies and gentlemen. This does conclude today’s conference. You may now disconnect.